PENSION SECTION NEWS

Actuaries Online

by James Weiss

Development is under way for ACTU- ARIES ONLINE, the Bulletin Board System (BBS) sponsored by the Soci- ety of Actuaries. This information and communication service, provided via CompuServe. will allow the global actuarial community to access infor- mation, identify resources, share ideas, and discuss issues.

Features of the system Include: l CompuServe basic services, which

comprises electronic mail (private messages), data transfers, an online reference library, and so on.

l An SOA communications exchange, which wilI allow the Society to distrib ute information quickly to members

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via the electronic medium. Online, real-time discussions among subsciibers.

l Message posting for others to ssan and respond to.

l Special topic conferences focusing on the latest issues. In a moderated con- ference, guest speakers/experts can be intetiewed by subscribers.

. Data libmries. in which downloadable tiormation is available to subscrib em preprints of -pape** meeting session transcripts and research reports, for example.

contburedonprrge17.odunmZ

Efict of Reconciliation Account on MinimumFunding

by Andrew T. Smith

OBRA 87 and the Single Employer- Pension Plan Amendment Act of 1986 made numerous changes to Internal Revenue Code Section 412. Among these were the additional funding charge, the quarterly contri- bution requirements and mandated interest rates for amortization of funding waiver bases. The additional funding charge and interest on delin- quent quarterly contributions appear as charges to the funding standard account with no offsetting amounts elsewhere in the minimum funding balance equation. The balance equa- tion was further upset by the pros- pect of interest on the outstanding amount of funding waivers at an interest rate that is diiferent from the rate used for the valuation.

To track new charges that upset the balance equation, actuaries be- gan informally using the reconcflia- tion account. Each year this account is charged with interest on the prior year halance and: l MdiUonalfundingcharge

l Interest on delinquent quarterly contributions

l Interest on iimding waiver bases at the xtquhed late to the extent such amount exceeds interest at the vaIuation rate.

In 7his Issue page PEW

Actuaries Online . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Minutes of the Combined Meeting of Articles Needed for News . . . . . . . . . . . . . . . . . . . 17 the Retirement Systems Practke Continuing Education Update . . . . . . . . . . 18 Education and Research Defined-Contribution AlternatIves Committees, April 2. 1993 . . . . . . . . . . . . . 15

to Defined-Benefit Plans: Recent Minutes of the Retirement Systems Publk Sector Experience . . . . . . . . . . . . . . . . . 4 Practke Advancement Committee

Effect of Reconciltatton Account Meeting, April 20. 1993 . . . . . . . . . . . . . . . . . 16 on Minimum Funding . . . . . . . . . . . . . . . . . . . . . . 1 Minutes of the Retirement Systems

Flash1 Election Results . . . . . . . . . . . . . . . . . . . . . . . 2 Practice Advancement Letters to the Editor ‘Pension Expense Committee Meeting,

1 Calculations for Cash-Balance July 13. 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Plans, - ‘Present Value of A Practkal Approach to Gains Vested BeneEts’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Analysis R&sited . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

TSA 199 l-92 Reports Features Three Pension Studies . . . . . . . . . . . . . . . . . . . 17

At any valuation date, the recon- ciliation account balance can be viewed as the portion of plan assets attributable to the accumulated value of past contributions due to the items mentioned above.

The reconcfliation account gained formal acceptance by the IRS when it was incorporated into the 1989 Schedule B.

Immedlate-Galn Methods Although it is not Immediately ap- parent, the existence of a nonzero reconciliation account balance (RAB) has an effect on the future minimum required contributions under an im- mediate-gain method. We examine the impact of the RAB on the present value of future contributions (PVFC).

If we let PVFNC represent present value of future normal costs and OB represent the net outstanding baI- ance of the amortization bases, that is, charge bases less credit bases, and CB represent a credit balance in the funding standard account (or, if negative, a funding deficiency), we have:

PVFC=PVFNC+ OB-CB. (11 This ardysis assumes that the

plan is not in full funding under the accrued liability full funding limit and does not consider future charges of the type that increase the RAB (henceforth referred to as reconcflia- Uon charges).

Using the following additional deflnitfons. A@B = Present of alI future

employer-provided benefits AL = Actuarial accrued liability LL4L = Unfunded actuarial accrued

liability,

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PAGE 2 PENSION SECIION NEWS SEPTEMBER 1993

Effect of Reconciliation Account on Minimum Funding continuedfrompage 1

let us state the balance equation as modified to include the RAB, UAL=OB-CB-RAJ3.

From basic principles we have, PvFB=Amvc+AL

=PvFNc+(mL+Aj =F’VFIVC+ (OB-CB-RAB]+A.

Solving for PVFNC.

(2)

(31

PVlTVC=lWF73-OB+CB+RAB-A. (41 Substituting PVFNC into Equation (1).

PVFC=AWB+RAB-A. (51 Analysis of Equation (5) yields a surprising result. We would expect that

future contributions would ‘pay off the difference between PVFB and assets, but Equation (5) indicates that the RAB is being “paid oif as well! In other words, even though the money in the RAB was contributed to the plan in past years and is therefore part of the assets, it must be contributed again (along with interest).

We could surmise ii-am this that the intention of the various reconcfliation charges is to provide for a -penalty’ to a poorly funded plan or one that did not make timely quarterly contributfons. The penalty increases assets and would be available to participants if the plan were to terminate, but future contribution levels are not reduced. That is. the ‘penalties” are not used to prefund the benefits.

Spread-Gain Methods with Bases For spread-gain methods such as frozen initial liabflity and attained age nor- mal that set up bases for changes in plan, assumptions and methods (as well as for OBRA 87 full funding credits and other sources), it can be shown that Equation (5) expresses the PVFC just as it did for immediate-gain methods. Using UFXL to represent unfunded frozen accrued liability, the deilnition of the normal cost gives us,

l’VlWC=PVFB-lIFti-A. (6) Using the balance equation to substitute for UFAL.

PVFNC=PVFB-(OB-CB-l&W-A. VI which implies

lwFc=lvFB+RAB-A. 03)

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Flash! Election Results The results of the Pension Section Council election have been tabulated. Congratula- tions to James G. Durfee, Donald J. Segal, and Michael M. C. Szel They will join the Pension Section Council at the Annual Meeting in October. Their terms will expire in 1996. Remaining on the Council are Brian FitzGerald. Ethan Era. and Ronnie Susan Thierman (terms expiring in 1994) and Silvio Ingui. Judith E. Latta. and Neil A. Parmenter (terms expiring in 1995).

The Section would like to thank the outgoing Council members for their leadership and dedicated work on behalf of pension actuaries. We appre- ciate the efforts of Ronald Gebhardtsbauer (Chairperson), Patrick F. Flanagan (freasurer), and Dale B. Grant during their years of service.

“We can sit here all day until the person who hid the pension

agenda speaks up!”

SEPI’EmER 1993 PAGE 3

Effect of Reconciliation Account

Q nMhimumFunding tintinuedfrom page 2

Therefore, as was the case for immediate-gain meth- ods, reconciliation charges do not prefund plan benefits.

Aggregate Method Under the aggregate method (as used to determine

the minimum required contribution). PVFTVC=PVFB-OB-(A-CB). (9)

Note that although bases are not set up for changes in plan, assumptions or methods under the aggregate method, bases may be present for OBRA 87 full funding limit credits. funding waivers, switchback from alternative minimum funding standard account, and shortfall gains and losses.

In applying Equation (9) to determine normal cost, some actuaries adjust the assets by the RAB as well as the credit balance. However, in a meeting held on Febru- ary 10. 1993 between the Enrolled Actuaries Program Committee and representatives of the Internal Revenue Service, as summarized in a booklet distributed at the March 1993 Enrolled Actuaries Meeting. the IRS repre- sentatives advised that this was incorrect. They pointed to the instructions to the 1992 Schedule B, line 9p, which state, in part,

“Valuation assets should not be adjusted by the

0

reconcUiation account balance when computfng the required minti~ing.’

(Note that this position may be recently adopted since the 1991 Schedule B InstrucUons contained no such statement.)

Substituting PVFNC from Equation (9) into Equation ( 11,

PVFlC=PVFB-A. (101 Note that even if the assets consist, in part, of an

RAB, the RAB does not have to recontributed. That is. for the aggregate method only, reconciliation charges are considered to be prefunding and, as such, reduce future contribution requirements.

What’s Reasonable? IRS RegulaUon 1.412(c)(3)-1 describes rules for determin- ing whether a funding method is reasonable. Section (b)(l) provides that under a reasonable funding method, the following will hold:

PVFB=PWYVC+OB+ IA-CBI. (11)

or PVFNC=PWB-OB-IA-CBI. (12)

Note that Equation (12) is a reproduction of Equation (9). Perhaps this reguIaUon is the basis for the position taken by the IRS representattves that assets should not be adJusted by the RAB in the aggregate method, that is. if Equation (12) does not hold, then the method is not ‘reasonable.’ However, if this is the case, then a quick comparison of Equation (12) with Equations (4) and (7) would lead to the conclusion that, ifan R.AB is present, then aggregate is the only “reasonable” funding method (with the possible exception of individual aggregate).

Conclusion Until future guidance is issued, actuaries are faced with an inconsistency between the formula underlying the aggregate method and that underlying virtually ali other commonly used methods. Perhaps, if the ‘penalv view of reconciliation charges is in line with the IRS thinking, the service will change the guidance with respect to the aggre- gate method and update the definition of reasonable fund- ing method.

If. on the other hand, a prefunding of liabilities is the desired result, a mechanism might be worked out that would allow a plan to apply its RAB to reduce the out- standing balance of its minimum funding bases, thereby shortening the remaining amortization periods or decreas- ing the amorUzation payments. This would have the effect of decreasing the PVFC for atl contributions ma& to the plan. Furthermore. if each new reconciliation charge was immediately used to reduce the minimum funding amorti- zation bases, the need for the reconciliation account would be eliminated altogether.

In the meantime. if you have clients with large nxon- ciliation account balances that want to reduce future re- quired contributions. why not advise them to switch to the aggregate funding method? This may not produce the lowest contribution requirement for the coming plan year, but the present value of future required contributions would clearly be minimized.

AndravT.SmWI.ASA.LsaConsultantcrtC~&Lybmndfn LoulsvfUe. Kentuclcy.

The authorgrateji~Ny ackrww&dgtts Ftank Borwn and James ifausnwtn of Coopers & L&rwd who OorUduted fdeasfi thfs aJade.

PAGE 4 PENSION SECIION NEWS SEPTEMBER 1993

Defined-Contribution Alternatives to Defined- Benefit Plans: Recent Public Sector Eqetience

by Scott K. Baker and Kathy Jenks Harm

All state governments and most units of general-purpose local gov- ernment provide retirement benefits for employees in the form of quaMied plans, the overwhelming majority of which are of the deflned-benefit type. In such plans, benefits are deter- mined on the basis of a formula, normally including the individual’s length of service, final average salary and percentage credit per year of servlce. Deflned-contribution plans utilize individual participant accounts to accumulate employer and employee contributions and related investment earnings to form the basis of retirement benefits.

Recent California legislation provides:

zt is the f.nterlt of the Legtsla- twe that contracung agencies in cm&nctdon with mmg- ntzed local employee ogani- zauons, deuelop azk?lmltive retirement plans that pmvtde benqflt.5 under a de$i.ned contribution plan

To someone unfamiliar with cur- rent developments in California in public sector retirement. the provi- sion may seem relatively benign, opening the door to change or choice in established retirement plans. However, recent issues of tilic Retirement Jcnu-nal and conversations with those more directly involved with the California perspective indi- cate that the provision is not viewed as innocuous by all parties, with an implication that a dellned- contribution plan alternative will result in a takeback by the employer and a loss to the participant.

This article flrst looks at partlci- paUon trends in defined-benefit and deflned-contribution plans in both the private and public sectors. Fol- lowing is an evaluation of the differ- ences between defined-benefit and defined-contribution plans, particu- larly because these di.fTerences may result in relative advantages and disadvantages to employer and employees. Then the article examines several situations in which public

sector employers have either con- verted their defined-benefit plans to defined-contribution plans or offered a defined-contribution alternative to individual participants.

Tmxts in Private and Public Sector Plans In the private sector, the number of defined-contribution plans and the assets in those plans is increasing, with defined-contribution plans increasing between 1975 and 1988 i?om 67 to 80 percent of the total number of plans and assets increas- ing from 28 percent to. 39 percent of total pension assets in the same period. A significant reason for the increase is the decline in the relative importance of sectors of the economy that have traditionally relied most heavily on defined-benefit plans, such as heavily unionized and older industrial enterprises [ 11.

The vast majority of plans in the public sector are still defined-benefit plans. The Bureau of Labor Statistics estimates that 90 percent of full-Ume state and local government employ- ees are covered by defined-benefit plans, while 9 percent are covered by de~ned-contribution plans [2]. The same study concludes that ‘public- sector defined-beneflt plans generally replace a greater proportion of eam- ings than private-sector defined- benefit plans, but private-sector employees are more likely to have supplemental defined-contribution pension plans,’ clung average replacement figures of defined- benefit plans of a hypothetical worker with 20 years of service and $25,000 per year in earnings at 20 percent in the private sector, 34.3 percent for state and local government employes with Social Security coverage, and 40.6 percent for those public sector employees without Social Security coverage 131.

Define&Benefit Versus DefifwKZontrtbution Plane The single specific characteristic on which the Internal Revenue Code

bases the definiUon of a deflned- contribution plan is the existence of individual accounts on which benefits are solely based [41. The single most important factor in determining the relative merits of a defined-benefit versus a defined- contribution plan at the individual level is tenure with the employer, which can rarely be accurately pre- dicted at the onset of employment. Funding Liability

A major advantage for deflned-contri- bution plans is that they do not have the potential for accruing unfunded liabilities. Costa are as predictable and budgetable from year to year as the salary levels on which contribu- tions are based. The level of contri- butions does not fluctuate with investment returns, employee mor- tality or turnover rates. Even though n employers directly face potential growing unfunded liability in defined-benefit plans, unfunded liability can also be adverse to employee interests. Bond ratings are affected by the unfunded liability of an employer, and higher bon-owing costs to the governmental unit may lead to fewer resources available to fund increases in employee salaries. Investment Risk

A significant difference between defined-beneflt and defined-contri- butlon plans is the nature of the employer obligation. In defined- benefit plans. the employer is obli- gated to pay benefits in accordance with the plan, while deflned-contri- bution plans require payment of con- tributions on an ongoing basis.

The resulting investment expo- sure in the two plans la opposite, with investment risk undertaken by the employer in a defined-benefit plan and by the employee in a deflned-contribution plan. Superior investment performance may reduce employer contribuUone in a deflned- benefit plan. while on the other hand n it will simply enhance potential retirement benefits in a deflned- contrlbutlon plan.

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SEl’l-EMBER 1093 F%NSION SECIION NEWS PAGE 5

Defined-Contribution Alternatives

l to Deflned-Beneflt F’lans: Recent public Sector Experience continuedfromp&e 4

Although not applicable to gov- ernmental’qualified plans, ERISA provisions that drive the design of all private sector plans essentially require a range of investment options to be available to plan participants. Many public sector plans follow this aspect of plan design and provide several investment options with dif- ferent risk/return characteristics.

Participant assumption of investment risk can lead to greater involvement and interest by employ- ees in their retirement plans. This could be perceived either positively or negatively by an employer. Of course, a participant has no guaran- tee or promise of a given level of fu- ture benefits, which are the basis of the appeal of defined-benefit plans. Portability Portability is the ability to transfer accrued vested retirement benefits from one employer to another. The importance of portability is rein- forced by the recent enactment of legislation at the federal level requir- ing that plan participants be permit- ted to directly roll over their pension plan distributions (other than annu- ities over life or life expectancy. installments for a period of ten years or more and required minimum dis- tributions) at termination of employ- ment to a subsequent employer’s plan or Individual Retirement Account [51. It is expected that all defined-contribuUon plans will pro- vide portability through rollovers, while in general deflned-beneAt plans will be unlikely to provide a signifi- cant degree of transferability except to other public sector retirement plans within the same state where some reciprocity may be provided. Further, direct rollovers from or to California public retirement systems are not authorized under state law 161. vesting Vesting refers to the rights of a par- Ucipant to a portion or all of a given benefit or to a specified percentage of the employer contributions account in a delined-contribution plan. Among state and local governments, defined-benefit plans tend over- whelmingly to have cliif vesting (100 percent vesting with a certain period

of service, with no phase-in). with roughly half of all participants required to have more than five years of service for full vesting [71. Since the employer has no need to impose strict reyuirements to control unfunded liabilities, vesting is fre- quently more liberal under a deiined- contribution plan, which may lead to increased acceptance by participants.

Individual accounts in defmed- contribution plans can continue to grow after termination of employ- ment, while deferred vested beneflts in defined-benefit plans are fixed at termination. As an example, a 43- year-old employee of a Council of Covemments in Pennsylvania left that local government position after nine years and nine months in a position that required ten years of service for full vesting. He calculates that reinvestment of the return of his own contributions will be worth more to him in retirement benefits than the monthly beneilt he could have collected at normal retirement age under the deiined-beneflt plan. The effect of the faster vesting and growth of account value aiter terminauon provides additional flexibfliiy in em- ployment opportunity to those who are in defined-contribution plans. Disahillty and Death Provisions Most defined-benefit plans provide substantial payments in the event of the disability or death of a partici- pant. Deflned-contribution plans tend to provide benefits based only on account value or incidental amounts of insurance within the plan. A major consideration in pro- viding a defined-contribuUon alter- native should be the provision of these benefits from some other source, such as a combination of group insurance and Social Security. Mmlnlstration In terms of administration, dedned- contribution plans have an advan- tage in that they do not rely on the services of an actuary to determine the amount of funding required to be made to the plan by the employer in addition to employee contribution if the plan is a contributory plan. Defined-contribution plans also face an obligation to provide for the edu- cation of plan participants in the area of investments, including the inherent potential for investment losses in deiined-contribution plans. Plan stafllng requirements ln

deflned-benefit plans tend to be more extensive than in deflned-contribu- Uon plans, which frequently rely on outside providers for investment pro- vision, employee education and plan documents. Plan costs in defined- beneilt plans are normally assumed by the employer, while most deflned- contribution plans assess ongoing fees to the participant. Recruitment, Retention, Morale Retirement benefits are often men- tioned as employee beneflts that can enhance the recruitment, retention and morale of employws. While pro- spective candidates who expect to be career employees may have a strong preference for a deiined-benefit plan, those whose future plans are uncer- tain may be expected to be more attracted to deflned-contribution plans. Clearly, deflned-benefit plans promote retention. since a career move normally results in no addi- Uonal accrual of retirement earnings under the plan. Flexibility in Benefit hyments An attractive feature in deiined- contribution plans in part balances the guarantee of a future monthly beneilt amount in a deiined-benefit plan. Participants generally have the opportunity to select from a much wider range of payout options in deiined-contribution plans, including lump-sum distributions. payments over a specified number of years or irregular payments to meet varying retirement needs. This ilexibfflty is perhaps most beneilcial to partici- pants who have a guaranteed source of monthly retirement income from another soume. such as an employer- provided pension or Social Security.

S- It is impossible for a person to deter- mine in advance whether a deiined- benefit or defined-contribution plan will provl& the greater retirement payout: the relative benefit for an individual can only be calculated after the tenure of career With each employer, earnings history, length of time in retirement payment phase and investment performance axe known, when it is too late to alter the outcome. A comparison of the impact of Job mobility on pension amounts for equal cost pension plans projected the annual payout available in three situations and concluded that over a

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PAGE 6 PENSION SECIIONNEWS SEFTEMBER 1993

Defined-Contribution Alternatives to Deflned-Beneflt Plans: Recent Public Sector Experience continuedfrom page 5

42-year career, the highest pension amount would be available to an employee in a defined-benefit plan with only one Job, while the lowest pension would be available to an employee with defined-benefit plans in five separate jobs. Faring better than the employee with five jobs but not as well as the employee with one job would be an employee who had been in defined-contribution plans, regani- less of the number of employers (81.

Since there are aspects of both defined-benefit and deflned-contribu- tion plans that are advantageous to both employers and employees, it becomes a challenge to plan admin- istrators and employee organizations to develop new approaches to plan design that provide the greatest com- bination of strengths to produce the best retfrement beneilts possible.

Experiences from Public Employers around the Country Three recent experiences of public employers demonstrate different approaches to the establishment of defined-contribution plans in place of or in addition to defined-benefit plans. Littleton. Colorado The City of Littleton. Colorado is a Denver suburb with a population of 33,000. In 1978. there was a state- wide division df fire and police per- sonnel into two groups for retirement benefit purposes: old hires (pre- 1978) and new hires. Local govern- ments generally then maintained defined-benefit plans for each group through the Colorado Fire and Police Pension Association (FPPA). with the actuarial rates for the groups calcu- lated separately. ‘Thus, starting in 1978, Littleton had separate plan groups and resulting contribution rates for old and new hires in Ure and police senrlce. for a total of four pension plans.

As a result of interest from local new-hire employee groups statewide, with strong employer support, a number of fire and police new-hire groups pursued the 0pUon of with- drawing from FPPA, and in 1988

both the fire and police new-hire groups in Littleton elected to with- draw from the state-run retirement system. The sentiment and votes in Littleton were overwhelmingly in favor of a locally administered Money Purchase Plan, a defined-contribu- Uon plan. The city’s funds held at that time by FPPA were returned to the city for crediting to individual participant accounts. Each partici- pant received credit equivalent to the return of the 8 percent contribution from both employer and employee, with associated earnings, from hire date. These participants also ben- efited from the allocation of forfeiture funds that the city had held in the plan. which represented an addi- tional %indfall’ to participants who were in the plan at the time of con- version from deflned-benefit to defined-contribution. Annual contri- butlons are now at the level of 9 per- cent for both employer and employee.

A significant feature of the con- version for formerly participating local groups was the maintenance of a disability benefit through FPPA. The disability benefit is offset by an actuarial projection of benefits avail- able from the Money Purchase Plan but does not require that any given level of benefits he actually with- drawn from the Money Purchase Plan. Health benefits are not avail- able for purchase by retirees through a group plan, which would be the case with an FPPA plan. Employer disclosure to participants in the Money Purchase Plan alerts partici- pants that they will be required to locate their own health care plan at retirement.

After six years experience in the Money Purchase Plan, acceptance by the oflicers is rated as ‘tremendous” by Martin Keilman. senior police ofhcer and former chairman of the Police New Hires Pension Hoard. He further indicates that the form of the plan is a compeUUve advantage in hiring and that new people coming on board are -ecstatic’ in their feel- ings about the benefit. The portabil- ity of assets gives substantially more flexibility in how long a participant chooses to stay, with employer con- tributlons fully vested after five years. This is especially in contrast

to other Colorado FPPA plans that have full vesting for new hires at 10

f-7

years and full vesting for old hires at as long as 20 or 25 years.

A member relations representa- tive from FPPA related that several retirement systems in Colorado at one time had never had to pay retirement beneilts. This tended to occur in Wealthy resort communi- ties.” where police and Are rarely spent their careers, largely because the cost of 1Mng was prohibitive for raising a family. For the employees in these communities particularly, the FPPA representative thought the defined-contribution alternative worked extremely well, providing a beneilt for the time the individual has served in the department. The representative also thought that those plan participants who shared in forfeiture allocations were especially well served. Further, a key to the conversions is the avail- ability of knowledgeable resources to local participants, including provi- sion of education in the area of investment options. Auburn, Maine The State of Maine has a unique statutory provision governing the portion of Maine State Retirement System (MSRS) covering local governments. Any individual who is employed by a governmental unit participating in MSPS and also the !hcial Security system may elect on an IndMdual basis not to participate in MSKS.

Auburn. Maine, a city of 23.000 with a diversiiled economic base in southern Maine, has set up a deflned- contribution plan for those general employees who opt out of MSKS. Since police and Are are not covered by Social Security, participation in the state plan for those employees is not elective but mandatory. In 1985. the city established a Money Pur- chase Plan with 11 percent combined employer and employee contributions and 100 percent immediate vesting. Approximately 15 to 20 employees dropped participation in MSRS and began participation in the Money Purchase Plan. Since MSRS had after-tax employee contributions,

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SEPTEMBER 1993 PENSION SECIION NEWS PAGE 7

De5ned-Contribution Alternatives to Dedned-Benefit Plans: Recent Public Sector Experience cantinuedfrom page 6

the contributions returned to partici- pants on their withdrawal were not eligible for rollover to the new plan.

Personnel Director Deborah Grimmig estimates that the reasons for electing the Money Purchase Plan are thought to be so compelling that 80 percent of new hires since 1985 have chosen participation in the defined-contribution plan. She does not think that portability is a major factor in the choice of participants because most employees assume they will spend their careers with the city. She attributes the choice prima- rily to the more liberal vesting provi- sion, since MSRS has IO-year cliff vesting and requires a fuIl30 years for half pay. She expects that a num- ber of employees would not take MSRS even if the delhred-contribu- tion alternative were not available.

Crimmig thinks that the defined- contribution plan is important in attracting new employees but not as

0

significant an employee benefit as the health care plan provided by the city. She also indicated that a learn- ing curve exists: when first in the plan, the participants have tended to take the most conservative invest- ments, and they are likely to be more sophisticated, long-term investors as plan participation has continued.

Several other local governments in Maine now offer defined-contribu- tion plans as an alternative to par- ticipation in MSRS. and the experience has been viewed as positive for both employers and employees. Deer5eld Reach. Florida A growing coastal community of over 45.000 north of Fort Lauderdale, Deerfield Beach adopted deilned- contribution plans for all general employee and firefighters hired after inception of the Money Purchase Plan in early 1990. Existing employ- ees were given the option of convert- ing to the new plan, with their initial credit being the greater of the present value of their accrued beneflt (assuming 100 percent vesttrig) or their employee contributions to date.

According to City Manager Barry Evans, the reason for requiring new hires to be in the deflned-contribu- Uon plan was that defined-benefit plan accruals had been raised to 3 percent per year of sexvice, a level that was projected to be prohibitively expensive over time. General employ- ees could retire at age 55 with 10 years of service, and firefighters after 25 years of service with no age requirement. Contribution rates in the new plan are 8 percent employer and 4 percent employee. These con- tribution rates are unlikely, even given optimistic investment experi- ence, to produce the retirement income streams guaranteed in the defined-benefit plan, particularly for flreilghters who could retire with generous benefits at a relatively young age.

Evans states that there have been no complaints from the general employees, and a number of employ- ees eligible to convert have done so, with the result that more general employees now participate in the defined-contribution plan than in the defined-benefit plan. The firefighters. however, have viewed the change in benefits more negatively. with no conversions to the new plan and the small number of affected new hires somewhat dissatisiied. Observationa The circumstances in Deer-Geld Beach, particularly for firefighters. appear to be substantially different. from those in Littleton and Auburn. Key factors in Littleton that appear missing in Deerfield Beach Elated to the substantial contribution levels to the new plan (18 percent in Littleton compared to 12 percent in Deerfield Beach) and the initiative of the ofilcers and support of the employer in the plan conversion pro- cess. The benefit levels in the old plan in Deerfield Beach were also substantially higher than those in Littleton. One strength of Auburn’s experience lacking in the other two situations is individual choice ln selection of dellned-benefit or defined-contributfon alternative.

While public sector experience with deflned-contribution plans is quite limited, the trends in the

private sector, economic realities in local governments, a more mobile public sector work force, and growing employee involvement in retirement planning suggest that defined-contxi- bution plans will continue to become more important. Most surprising to the authors is that relatively few governmental units have pursued an approach that combines a defined- beneilt plan with relatively modest but guaranteed retirement payments with a de&red-contribution plan that gives the participant a truly portable benefit and entourages active involvement in planning for the future.

References

1. Piacentini. Joseph S. and Foley, Jill D. EBRI Jhtabook on Empkyee BeneJb, Second EdiUon. Washington D.C.: Employee Beneilt Research InsU- tute. 1992. p. 115.

2. U.S. Department of Labor, Bureau of Labor Statistics. Employer Ben- efitsinStateandLucaIGovem- men&. 1990. Washington, D.C.: U.S. Government Printing Oflice, February 1992. pp. 3 and 71.

3. EBRl Databook on Employee Ben- efits. p. 96.

4. Internal Revenue Code, Section 414(i).

5. Unemployment Compensation Amendments Act of 1992.

6. -Change in ‘Rollover’ Require- ments: What Does It Mean for Public Retirement Plans?’ R&Iic Retirement JoumalVol. 3. No. 8 (August 1992): p. 5.

7. EBRl Data&ok on Employee Ben- em. p. 133.

8. Congressional Research Service, Pension RxtabUUy, June 1988. as cited in Goldsmith, Marta V.. Pen- sbn Rn=t.abflUy and Pmsenmtlon for state and LAxal couf?mment.s. Chicago, Ill.: Government Finance Officers Association and National Association of State Retirement Administrators. 1989. p. 7.

ScuttK.BakerfswlththeNationdSales Croup and Kathg Jenks Hams fs Senfor Sendoe Ad&or at ICMA Rethment Copodfon 61 Washfngtan D.C.

PAGE 8 PENSION SECTION NEWS SEFl-EMBER 1993

A PracticaZ Approach to Gains AnaZysis Revisited- by Andrew T. Smith

The analysis of actuarial gains and losses by source has long been an invaluable tool for the pension actuary in performing a defined-benefit pension plan valuation. Such analysis provides a measure of the appropriateness of each assumption and may reveal a faulty valuation technique. Of the numerous papers on gains analysis, Josiah Lynch’s landmark paper, “A Practical Approach to Gains Analysis:” has probably been the most influential for its impact on the methods actually used by pension actuaries in performing gains analysis under a multiple decrement valuation model. The Lynch paper provides a very complete treatment of the subject, covertng both immediate-gain and spread-gain funding methods. Fur- thermore, the formulas are developed such that they are practical from the perspective of a valuation system pro- grammer yet still maintain mathematical integrity.

Lynch’s approach to gains analysis involves stating each type of gain or loss in terms of the difference between actual release of liability occurring during a given year and the expected release of liability during the same period. In the discussion of liability gain or loss arising from an individual immediate-gain funding method, an expression for the expected release of liability is developed that, under certain circumstances, produces values that are only approximations of the true releases. This article presents an intuitive formulation of expected release, examines the difficulties in using such a formula in the programming of a pension valuation system, and. finally, derives an alternative expression for expected release that is both practical and precise. The introduction of an unexpected approximation into Lynch’s formula and the magnitude of the error involved in using this approxima- tion also are addressed.

Notation Throughout this article we examine a single plan partici- pant, active at Ume 0. and the gains or losses arising from the valuation performed at time 1 as compared to expected values based on the valuation at time 0. This article is not intended to provide a complete development of gains and losses due to all possible sources; it concen- trates solely on the gain or loss due to decrement (or sur- vival) during the year. Gains and losses caused by data corrections. salary experience, asset return, and other causes are covered in Lynch’s paper. The special case in which the probability of decrement during a year is equal to 1 is also not considered.

The notation comprises standard life contingency symbols, pension-specific symbols used in the Lynch paper and a few symbols invented or modified specifically for this article. The nonstandard notation is described below ,ALr = Accrued liability at time t for a single participant

PC = Normal cost at time 0 for a single participant V = Accrued liability (reserve) at Ume 1 for a single

participant. V=,AL,; see Lynch’s equation (48).

‘Lynch. Josiah M.. Jr.. ‘A RacUcal Approach to Galm Analysb.’ Yfhnsactlom s/the Sock?& ofAchmles XXVII (1975): 4!2!.3-439.

EV =

v =

NL,=

NL=

E&=

ER;=

ek =

Expected accrued liability (reserve) required at time 1 for a single participant (as calculated from information available at time 0). EV=(,AL,,+,NC)( 1 +U: see Lynch’s Equation (10). Expected liability (reserve) at time 1 assuming participant has survived in active status to that time (as calculated from information available at time 0). Expected year-end value of new liabilities should the participant be subjected to decrement from cause k during the year (as calculated from information available at time 0).

Expected new liability given that decrement due to some cause has occurred. (This is a weighted average of the qs using the @s as weights.) Actual release of liability. if any, arising from decrement k. (Release is determined as the difference between the expected liability at time 1 assuming no change in status, that is, assuming an active participant is still active, and the actual liabfliiy at time 1.) Expected release of liabflity arising from decrement k. Lynch’s expression for ER,: this is stated in his Equation (47) as q(EV-F&)/Z, F-Y

Error involved in using Eq in lieu of E&. s=ER,-ER;

Note that the standard actuarial symbols lr, d,, q", and pt are used with subscripts that represent times rather than ages. That is. a subscript of t represents the appropriate value for the given participant corresponding to his or her age at time t.

Intultlve Definltbn of ER, Let the actual release of liability at time 1 due to cause k Wy be defined as:

A%={ V’ -V. decrement due to k 0, otherwise. 11)

We can view A& as a random variable that assumes the value (V-V) with probability @ and the value 0 with probability (l+q. The expected release (ERJ must then be defined as:

Es=E[ARJ. (2) V’. which is not affected by any event occurring

during the year. is a constant in Equation (1). In contrast, Vassumes the value of an accrued liability if the parti- cipant survives in active status to time 1 and is the present value of the appropriate benefit if decrement occurs during the year. However, as q is defined as the expected value of Vshould decrement from cause k occur, we can write:

Then

NL,= EWI decrement due to k]. (31

canUmedonpcage9,cdunml

SEPTEMBER 1993 PENSIONSECTIONNEWS PAGE 9

0 A Practical Approach to Gains Analysis Revisited continued from page 8

EIS, =E(ARJ = @ E[(V’ - V) I decrement due to k]+(l- @O (4) = g(kl(V - Aq.

This statement of EIZ, [Equation (4)] was also sug- gested by Paulette Tino in comment 2 of her discussion of Lynch’s paper. Lynch’s formula for E&. which is referred to as ER; in this article, can be found in his Equation (47) and is stated below:

ER; = d,“(EV - NLJ

1, . (5)

The Problem In calculating liability gains and losses, a valuation com- puter program typically makes at least three ‘passes’ through the data (additional passes are required to recog- nize the effects of data correcttons. plan changes, assump- tion changes, and so on). The three basic passes are described ln Table 1.

TABLE 1 ,

Pass Description Purpose

1 Valuation at time 0 Reproduce values actually used at time 0, compute EV, compute ERR,‘3

Valuation at time 1 Compute V’. compute liability recognizing actual status at time 1 but using expected salaries

Valuation at time 1 Using actual salaries, compute V (final liabilityl, AR.‘s,. various gains or losses.

The calculation of V in pass 2 bears special attention. If V’ is calculated directly from its definition. an additional pass performing a valuation at time 1 with the assump- tion that all time 0 active participants remaln active would be called for. To avoid this additional pass, V’ must be cal- culated from other values obtained during pass 1.

Note that once the time 0 accrued llabflity and normal cost have been reproduced in pass 1, EV can be calculated from:

EV= (&+,hC)(l + i). (6)

V’ can then be calculated during pass 2 by using the following formula given by Lynch as EquaUon (43) (thereby meeting our objective of avoiding an additional pass through the data):

v’= EV + x ER,/ (7) k

Unfortunately, this procedure gives rise to a problem if we intend to use EquaUon (4) to calculate Eq. Namely, E& depends upon V’, but V’ cannot be calculated until all Eqs are known. It was this problem that forced Lynch to bypass the obvious statement of E& shown in Equation (4) in favor of the approxlmatlon ER; (which does not involve V’) shown ln Equation (5). However, we demon- &rate that by restating V’ in terms of certain values (all of which are available during pass 1) and substituting the result into EquaUon (4). we can derive a precise yet ‘computationally frlendl~ expression for EI$.

Note that EVb the expected resenre required at time 1. Because we are not considering data corrections, sal- ary experience different than assumed, partial years of service. and other complicating factors, we have:

EV = E[Vj (81 = pfv’ +T *NT.&.

Deilning the expected new liabihiy given that decrement horn some cauSe has occurred m as

XT= pi% pI!T% q&RI = (l-P#y ’

we have

EV=p,W+ (1 -p@

Now, solving for V’,

(9)

(10)

EV-(1 -poqz (11) v’=

PN 0

(Note that Equations (8) and (11) are presented in very similar forms by Lynch in his Equations (44) and (45).)

Substituting V’ as stated in Equation (11) into Equation (4).

ERk = e(V’ - NLJ

(12)

We now have, in EquaUon (12). a precise formula for E& that can be completely evaluated during valuation pass 1.

The Error Involved In ER; At this point it may not be obvious what error (if any!) is introduced by using ER; in lieu of Eq. To mcamine this issue more easily. we restate Equation (5) by using:

as

ER; = $&Y-N%). 0

(13)

(14)

(Note that in the special case where N&=m EquaUon (12) simplifies to EquaUon (14). We would conclude that thls is the assumption underlying the derivation of ER; as an approximation to ERJ

PAGE 10 PENSION SECIIONNEWS SEPTEMBER 1993

A Practical Approach to Gains Analysis Revisited continued from page 9

If we deline the error involved in using ER; as e,=E&-ER; , we can subtract Equation (14) from (12) to obtain:

ek = $ (1 - ptNNL,-m . (15)

From Equation (15). ek=O (implying ERk=ER; 1. if and only if NI+=mor c@=O. Therefore, assuming that a par- ticipant is subjected to decrement k and at least one other decrement between time 0 and time 1. it is very unlikely that ER; will produce exact expected releases.

We would expect that the size of ek would be relatively small compared to E&. or at least that er, does not “blow up” under any special case. Note that if @ is large relative to the other probabilities of decrement acting on the participant, then s will necessarily be close to M, causing the (N&-N4 term to be small. If @ is relatively small, then ek is easily seen to be small as well.

The real question for those who have used one of the popular valuation systems that employs E& to calculate expected releases is: ‘How much have past gains and losses been skewed due to the use of this approximation?” The answer, of course, depends upon such factors as the actual employee data, the funding method, the decre- ments, the actuarial assumptions, and the plan formula. However, initial (though limited) trials conducted by the author showed the error, as a percentage of expected release, to be less than 2 percent if mulUple retirement ages are not used, and less than lb percent otherwise. The greatest degree of distortion seems to occur in the situation in which a large retirement decrement and a death decrement are both acting on a given participant during the year.

Note that-while each individual ER; may be only an approximation of the corresponding E%. the sum of ihe ER; ‘s produces the precise total expected release! This can be verified by showing the ek’s sum to 0:

F 4= q$t (I- pg(NL-m

= (qsrnN$ -EC&M) k

= [ 1 ’ ;T 4 &MNLk - F$imN&) (16)

= 0.

This property is a direct result of the way in which approximation was introduced into Lynch’s derivation of expected release. In going from Equations (46) to (47) in his paper, Lynch’s implicit assumption was:

F J7rtJ = F g(r3 impliesf(r3 = gfni for all n.

which clearly need not be true in all cases.

Summary Although the number of defined-benefit plans may be, for the time being, declining, there is still a place for the study of gains analysis. Because FASB Statement 87

requires the use of the projected unit credit funding method for calculation of pension expense and because this has prompted many plan sponsors to adopt this cost method for funding as well, the analysis of gains and losses under indMdual immediate-gain methods may be an especially timely topic.

This article is not intended to replace or criticize the Lynch paper. Rather, ln presenting Equation (12) as a precise yet practical method of calculating expected releases, it aspires to present a small refinement to the breakthrough techniques developed by Lynch. Certainly nothing said herein should diminish the stature of the Lynch paper or in any way detract from the important contributions he has made to the development of the modem valuation system and to the held of actuarial science.

Andrew T. Smfth, ASA, fs a Consuhnt at Coopers & Lybd in LoufsufIZe. Kentucky.

Discussion of Preceding Paper by Josiah Lynch

Actuarial gain and loss theory is enriched by Andrew Smith’s paper “A Practical Approach to Gains Analysis Revisited,” which sets forth a detailed analysis of the

,-,

mathematics of expected releases. His conclusions are correct and well presented and are a welcome addition to the actuarial literature.

The ‘Smith‘ and “Lynch” approaches produce identical total expected releases. Smith derives the total by computing actuarially correct expected releases for indMdua.l decrements and summing the results as shown in Equation (12) of his paper. His method is clearly definitive.

My approach. on the other hand, is to compute the individual releases by a reasonably close approximate method, shown in EquaUon (5) of his paper. As his paper notes, the two methods produce the same total expected releases. For my purposes, the computational conve- nience and speed gained by my method make up for the small deviations in individual releases. Programming simplicity and computing speed arise from bypassing the need to calculate the decrement-weighted expected new liabflity at time 0 deflned in Smith’s Equation (9).

Smith’s paper describes the differences between the two methods and quantiiies the precise amount of the error in the approximation for each expected release in his EquaUon (15). As he noted, the errors are offsetting and sum to 0.

Smith is the first actuary to discover and chronicle the approximation to lndMdual expected releases ln the 18 years since the publication of my original paper. The profession is indebted to him for his contribution to the actuarial gain and loss literature.

Jodah Lynch ASA, is Restdent of L.g~~hml Systems hmrp~mted . hReston# vilgfnia

SEITEMBER 1993 PENSION SECIION NEWS PAGE 11

&&t.ers to the Editor “Pension Expense Calcubtlons for Cash Balance Plans” Dear Dan: In the Junk 1993 issue of The Pen- sbn Fonun. Ning Yuen Chen and Stephen Femstrom present a well-

I written paper that proposes rules for determining the PBO benefit under the projected unit credit actuarial cost method for cash balance plans. The-y conclude that a pro rata alloca- tion of the projected benefit at decre- ment age is reasonable for cash balance plans as long as the interest rate to be used to determine the pro- jected account balance at decrement age is greater than or equal to the assumed salary scale. If this condi- tion does not hold, the authors pro- pose to use the traditional unit credit actuarial cost method. They also conclude that approaches used by actuaries to reflect the front-load&g of benefits generally found in cash balance plans (regardless of the relationshlp between the Interest rate and the salary scale referred to above) produce excesstvely acceler- ated allocation to past service relative to the pro rata allocation approach. I am uncomfortable with these conclu- slons. Figure 1 illustrates my concern.

Assume an employer sponsors a traditional career average plan with the same rate of benefit accrual for each year of service. Figure 1 fflus- trates the pattern of the accrued benefit (ABO, CA) and the PBO ben- efit (PBO. CA) for an active partici- pant in such a plan. Further, assume that on the valuation date the plan is changed to a cash balance plan. The new cash balance plan provides a 5 percent lower projected benefit at decrement age, but the new accrued benefit pattern (ABO. CB) is more front-loaded than the old traditional career average plan. Under the ap- proach suggested by Chen and Femstrom. the PBO for this partlcl- pant (PBO. CB) would be decreased by 5 percent as a result of the plan change, even though the partici- pant’s accrued benefit is increased

Figure 1 I I .L

IIneqcn pm. CA ABQ$B PB&CB

Age on Val. Date I

Decrement I

Figure 2 I

ABO,CA PW,. CA ABQB PB&CB

Age on Val. Date I

Decrement 1

by 24 percent. I don’t find this result to be necessarily reasonable or con- sistent with paragraph 40 of FAS 87.

In the December 1986 Issue of The Penston Fonun. 1 presented a generaked approach for determinlng the actuarial accrued liability under the projected unit credit actuarial cost method. The approach was revisited In the September 1991 Issue of The Pension Forum Under this approach (which I refer to as the adjusted accrued benefit method),

‘W

the PBO benefit equals the accrued benefit under the plan multtplkd by the ratio of average pay at the expected decrement age to the average pay at the valuation age. For a career aver- age plan, average pay at decrement age would be the average of all pays fi-om entry age to decrement age, while average pay at the valuation date would be the average pay from entry age to the valuation date. Thls

ax1thmionpage12.cdumnJ

PAGE 12 BNSION SECTIONNEWS SEPTEMBER 1993

Letters to the Editor wnttnued fivm page 11

ratio can be simplified by making assumptions for historical pay.

For the traditional career- average pay formula with the same rate of benefit accrual for each year of service, the adjusted accrued ben- efit method produces a pro rata allo- cation of the projected benefit. As I indicated in the September 1991 issue of 7he Pensbn Fbrwn ‘if you like the difference [between the PBO and the ABO] for a plan with no changes in rates of benefit accrual, then you’ll love it for plans with changes in accrual rates.”

Figure 2 illustrates the same example as described above, except the adjusted accrued benefit method is used for determining the PBO benefit. Under this method, both the accrued benefit and the PBO benefit as of the valuation date are increased by 24 percent as a result of the plan change.

Presumably, Chen and Fernstrom would argue that the adjusted accrued benefit method produces an “excessively accelerated expensing rate” for the example fllys- trated in Figure 2. By deflnitlon. however, the allocation between past service and future setice under this method is no more %xcessiveIy accelerated’ than when a pro rata allocation is used for a plan that has the same rate of benefit accrual for each year of setice. Further, I find the method produces results that clients with cash balance plans (or any kind of career average plan) can easily understand.

Kenneth A. Steiner, FSA Consulttng Actuary me Wyatt compwy Welles&y Hills. Massachusetts

Authors’ Response: We would like to make several points in response to Ken Steiner’s com- ments on our recent article in the June 1993 issue of The Pension Fonun First, our analysis of other approaches to expensing cash value plans was limited to a single method that has been presented at actuarial conferences. We do not presume to pass judgment on ail methods cur- rently used in the actuarial commu- nity. In fact, because we perceive this to be a very “gray area,” our intent in publishing the article was to put forth an approach we consider to be reasonable whfle pointing out a concern (that is. ‘excessively acceler- ated allocation”) that might result under some methods of dealing with the problem.

We acknowledge the anomalous result (increased AI30 with decreased PBO) that results from the conver- sion of a career-average plan to a more front-loaded cash balance plan. However, we note that the same result would occur under both the regular projected unit credit method and Steiner’s method if a flnal-aver- age pay plan was converted to a career-average plan intended to deliver slightly lower proJected ben- efits. We think there is widespread acceptance of this result and do not consider it to be a conflict with para- graph 40 of FAS 87.

Whether we would consider Steiner’s method to produce ‘an excessively accelerated expensing rate’ could be a function of the un- derlying interest crediting and salary assumptions in the cash balance plan. Steiner’s method works very well for final-average salary and

TABLE 1

career-average salary plans. The method may, however, produce anomalous results for some unit accrual designs, including cash balance plans.

For example, consider a cash balance plan with a 4 percent-of-pay annual allocation, a 10 percent inter- est crediting rate, and an annual age 65 annuity conversion factor of 10. Assume the annual historical and expected salary increase is 5 percent, and assume a participant hired at age 35 is expected to retire at age 65. Table 1 shows the proJected progres- sion of career average pay relative to accrued benefits.

Note that at age 55. the ratio of projected career average pay at re- tirement to current career average pay is 134 percent. However, the pro- jected age 65 benefit is only 124 per- cent of the current (age 55) accrued beneflt. Under Steiner’s method, the PBO for the participant would be based on an attributed benefit that exceeds the projected normal retire- ment benefit. In this situation, we would consider the allocation to past service to be excesstvely accelerated.

Ntru~Y.CheqFsA VLce Restd.ent and ConsuMng Actuay Stephen C. Femstrom, AS4 Senior Technical Consultant W.F. Conuon St L.oufs. lutssowi

contlnuedonpoge13,cdumnl

Age Annual Pav

35 $10,000 45 15,513 55 25,270 65 41,161

Career Average Projected CAP Ratio: Pav (CAP) CAP Proi./Cur.

$12,578 $22,146 16,533 22,146 22,146 22,146

-;.76 1.34 1 .oo

Accrued Benefit

$5,193 $10,502 2.02 8,454 10,502 1.24

10,502 10,502 1 .oo

Projected Ben. Ratio: Benefit Proj./Accr.

SEPTEMBER 1993 PJZNSIONSECIIONNEWS PAGE 13

Lettera to the Editoi 0 wnttnuedfivmpage 12

Present Value of Vested Benefits Dear Dan: I am writing in response to your editorial in the June 1993 issue of PensfonSectbnNews andt0Mat-y Adams’ comments in the May 1993 issue of The Actuary about the calcu- lation of the value of vested lxneflts in U.S. pension plans.

First, I think it is interesting that Adams says that the value of vested benefits should not just be the value of accrued benefits for vested employees. Although Actuarial Standards of Ractice No. 4 &SOP 41 includes many specific examples in which this is not the case, the defini- tion of the actuarial present value of vested benefits in Section 11.4 of the standard states that -... the actu- ary should calculate the accrued benefit as of the calculation date. This benefit should then be multi- plied by the vesting percentage defined under the plan.”

In the public sector, the value of vested benefits is reported only in connection with the disclosures required by the Governmental Accounting Standards Board (GASB). PracUce regarding the calculation of vested benefits has evolved based on two viewpoints. One is that the vested benellts are valued using a ‘private sector’ approach as in SFAS 35 and 36 and detailed in ASOP 4. The other is that this type of mea- surement is meaningless In the pub- lic sector and that the value of vested benefits (actually the vested portion of the PBO) should simply be reported as the PBO (which includes salary projection) for employees who am vested. Either approach is acceptable to the GASB. as long as the actuary discloses which method is used. In my opinion, the GASB is a ‘higher authority” than the ASB in this instance; that is. the procedures in ASOP 4. Section 11.5(a) are not applicable.

In addition to differences between public and private sector practices, I believe there can be valid differences in calculating the value of vested benefits with respect to areas that ate not discussed in the ASOR For example, many actuaries believe that disability and death benefits are not

vested until a member is disabled or dead, but this is not specffically stated in the ASOP. In a quick read- ing of the statement, the only refer- ence I found that would indicate that death benefits might not be consid- ered vested is a footnote on page 23. The tramples of vested benelit calcu- latlons do not refer to death or dis- ability benefits. To imply that there is a clear standard detailing how every type of benefit should be valued for vested or accrued benefit purposes is. in my opinion, an overstatement,

In summary, I fear Adams’ crlti- cisms may have been too sweeping. There could have been good reasons for the calculations she reviewed to have been done as they were.

Jane D. Pacdi FSA ConsulcLrag Actuary

Author’* Response: Perhaps there has been some misun- derstanding about the point I was making the Tsk, tsk’ addition to my editorial in the May issue of The Actuary. The point is that we have ASB Standards of Practice that we must follow under our Code of Pro- fessional Conduct. When a Standard of PracUce defines a term, an actu- ary, presenting a measurement labeled as that deflned term, should understand the term. The reader of a report should be able to assume that the actuary is following the dellnition in preparing the measurement, because If something else were used, the description would be diiferent.

With respect to the specific term ‘actuarial value of vested benefits.” It should be noted that the underlying concept in ASOP 4 was developed in the mid- 1969s when the Accounting Principles Board Issued its Opinion No. 8. Over the years them has been no change from the original concept that, for active employees. the employees’ vested benefits are Included, and any benellts to which an employee may become entltled through advancement of age or ser- vice are excluded. Because they are forfeited when the employee termi- nates service, benefits in excess of the vested benefit. which may become payable upon disability and death in active service, are also excluded. In ASOP 4. this concept

is not assigned to either private or public sector plans.

I think it is not necessary to come to the ‘higher authoriw ques- Uon that Ms. PacellI has noted. I cannot see how the GASB can be a higher authority in a situatfon in which the GASB has made it clear that no definition is in effect or even contemplated. I think it would be fairer to say that the professional judgment of some actuaries indicates that for public sector plans, disclo- sures of projected values, different from those described in Section 11.5(a) of ASOP 4. are appropriate, particularly in view of the fact that the GASB was well aware of ASOP 4 and made no attempt to disavow the Section 11.5(a) concept. Other actuaries have used the value of accrued benefits without salary pro- jection (why?).

In any event, there is no lnten- tlon of attempttng to stifle any actuary’e exercise of professlonal judgment. As Ms. Pacelli noted and ASOP 4 (Section 13.3(i)) Indicates, aII that is needed is disclosure of what methods have been used.

In spite of the concerns noted, I feel that “I’&, tsk- accomplished its intent to remind actuaries that it is their responsibility to understand the Standards of Practice (how many did not know the difference between the value of vested beneflts and the value of vested employees’ accrued benefits?) and to folknv them, with appropriate disclosure of any deviation from the Standard.

Other agencies (governmental or quasi governmental) may call for the disclosure of actuarial values. In such case, it could be expected that an actuary would use the procedures of the appropriate Standard. (If an agency should require a methodology to determine values that are different from that under a Standard, this should be disclosed when communi- cating these values.)

I trust that any time we see the ‘actuarial value of vested benefits,” or any other dellned term with any necessary notes, there will be no problem in knowing exactly what Is there.

MaryHardlmanAchms.ASA Cbnsuitty Actuary West Cbwge. New Jersey

PAGE 14 PENSION SECIIONNEWS SEPTEMBER 1993

Minutes of the Retiretint Systems Practice Advancement Committee Meeting Juty 13,1993 Washington, D.C. Attending the meeting were: Harry Garber (SGA Vice President), May Riebold (SGA Board Representative), Pat Scahill (SGA Board Represen- tative), Mary Adams (Chairperson. Pension Committee of the ASB), Joe Applebaum for Mike Sze (Chairper- son, SGA Retirement Systems Re- search Committee), and Judy Anderson (SGA Staff).

Harry Garber reviewed the dis- cussion on SGA services that was held at the last Executive Committee meeting. He listed the following four points for the Committee to consider:

1.

2.

3.

4.

SGA must be part of the structure in each country. This relates to maintaining close Ues with the Academy in the U.S. and the CIA in Canada. We must pay attention to the cost of providing services and manage it. Along with direct costs, volun- teer time should also be included. In additfon. we should consider who is paying the cost (for example, employers paying for time spent by volunteers). We should individualize services to meet the needs of different groups within the SGA membership. We should take advantage of the advanced technology that is available.

We discussed a vision for the practice area and the services it can provide. The Professional Develop- ment Committee will be asked to concentrate on the format used for providing formal continuing educa- tion. The Practice Education Com- mittee will be asked to continue to

concentrate on the creation of ‘infor- mal’ continuing and basic education materials.

In addition. we discussed the possibility of a committee to concen- trate on the uses of advanced tech- nology and the delivery of SGA services to retirement systems actu- aries (that is. the electronic bulletin board). This new group would also have responsibility for indexes of published materials.

Finally, we discussed statistics derived from a database of pension actuaries created from the SGA’s computer flles. The database lnfor- mation on meeting attendance shows that only a small percentage of the SGA-member pension actuaries attend meetings. Work will proceed on meetings but with recognition of the small numbers that take advantage of them.

For the afternoon meeting, the Committee was joined by members of the Pension Practice Council of the American Academy of Actuaries. Both groups reviewed their purpose within each organization’s structure. We then discussed the retirement systems-related projects that the Academy and SGA committees are currently working on.

For the Pension Practice Council, these include the following:

PBGC reform: submitted comments and testilIed at heating Budget reconciliation: submitted comments on proposed 4Ol(a)(17) Changes Mertens de&Ion: submitted com- ments and background paper on proposed legislation to ovlerturn the decision

Working on a standard on social insurance programs to present to the ASB Considering update of a mid-1980s study of pension ftmding methods and assumpUons.

For the Practice Advancement Committee, these included the following:

After this overview. the discussion focused on meetings and continuing education. There was a consensus that both groups should work together to promote cooperation and avoid overlap.

At least one joint meeting per year between the Committee and the Council is anticipated for the future.

Respectfully Submuted, Joseph Appkbaum FSA

Producing the UP-94 and GAM-94 mortality tables Compiling an experience analysis of employee turnover retirement and disability Producing a symposium of papers on funding adequacy and related issues Researching defined-contribution plans and benefit adequacy Working with the Pension Section on a mvised meeting format Distributing a Pension Section f-7 membersurvley RevIsingEcaumdcstatfstlc.sfi l+rlskm - to include quaxterIy updates and. possibly, health statistics.

SEI’IEMBER 1993 PAGE 15

@nutes of the Combined Meeting of the Retirement Sustems Practice Education and Resew& Committees April 2,1993 Washlngton, D.C. Editor’s Note: Meetings of the Ret&- ment Systems Fractke Education and Research Committee alle held Jo&t@

4 in the morning session and sepa- rately tn the a-n sesstan. The separate (amnl se&on of the Practice Education Commtttee was reported tn the June 1993 issue of Pension Section News.

In attendance were: Joe Applebaum, Chris Bone, Bill Farquhar, Rick Eaye. Ed Hustead. Rita Lawlor (Co-chairperson), Dave Lesueur. Lindsay Malkiewich, Bill Sohn. Mike Sze (Co-chairperson), and Henry Winslow. Also attending was Judy Anderson, Society representative. 1. 3

l 2.

3.

4.

5.

.m

The minutes of last meeting were approved as amended. The need for new members was discussed. The need for members with Canadian experience and small-plan experience was observed, and possible candidates were mentioned. Interest expressed by other actuaries was also discussed. The next meeting will be on July 9 in New York City at Ernst and Young. The fall meeting will be in New Orleans on October 23. Mike Sze and FUta Lawlor dis- cussed the December 3 meeting of the Retirement Systems Practice Committee. Mike Sze reported on a conference call on pensioner mortality and a conference call of the Research Coordination Committee. Bill Sohn reported on the last meeting of the Ameri- can Academy of Actuaries’ pen- sion committee. Chris Bone and Bill Farquhar dis- cussed the Retiree Health Task Force’s deliberations. The focus has been on the shape of the inci- dence of claims curve. An impor- tant Implication of this is whether the benefit should be thought of as essentially an annuity or a life

insurance type of benefit. The Retiree Health Task Force should be encouraged to perform sensi- tivity analyses for this Issue. A number of Issue identification and budget issues were discussed. The need for coordination with the Health Research Committee and the FAS 106 Task Force, as well as the need for claims data, was noted. Bffl Farquhar discussed his issues memorandum on post- retirement health topics. Mike Sze noted that health trend rates should be published. There was also a brief discussion of the impact of national health plans on trend rates.

6. Bill Sohn discussed the progress on the funding adequacy sympo- sium. A number of potential con- ‘tributors have come forward, and some people whose contributions might be of particular Interest have been contacted. Plans for publication by mid-summer look good. A ha&day editorial meeting was scheduled for April 19 at the Equitable Life Assurance Society in New York City.

Afternoon Meeting of the Retlranent Systems Research Commlttee

In attendance were: Joe Applebaum. Chris Bone (vice- Chairperson), Ed Hustead. Dave LeSueur. Lindsay Malkiewich. Mike Sze (Chairperson). and Henry WInslow. 1. Lindsay Malkiewich discussed the

work of the GAM 94 Table Com- mittee. A basic table has been developed and will be sent to the UP 94 Table Committee. There will be a strong relationship between the two tables-the UP 94 table will be the basis for the CAM 94 basic table. Lindsay Malkiewich noted that to develop age-specific safety margins, both stochastic modeling and basic statistical

2.

3.

4.

analysis were used. He also dis- cussed the develoDment of age- specific mortality improveme’;lt factors. Among other things, resuIts in Social Security Actuarial Note 107 indicate that recently there has been smaller mortality Improvement at ages above 85. Finally, he noted that the table will not have a terminal mortality rate of 1: instead the mortality ratewillbe0.5atages 110 through 115 inclusive. Ed Hustead discussed the work of the UP 94 Table Committee, which is working from the CAM 94 data. This, with potentially minor varia- tions, will be used to produce the UP 94 Table. Joe Applebaum and Ed Hustead discussed the task force on termi- nation/retirement experience. An organizational meeting was held on March 9. Richard Joss and Barthus Prien have joined the task force. The task force plans to solicit plan experience on pension plan decrements other than mortality from consulting firms and actuaries serving large public plans. Henry Winslow noted that the retirement inci- dence rates among John Hancock’s terminated vested participants was much lower than expected and suggested that the studies separate the experience of termi- nated vesteds. Dave LeSueur discussed a study on defined-contribution plans and retirement income adequacy. This would be done by a survey of retirees from delined-contribution plans of large sponsors.

5. Mike Sze discussed budget issues for projects. He noted that there was a need to submit budgets by April 15.

PAGE 16 PENSION SECTIONNEWS SEPl-EMBER 1993

Minutes of the Retirement Systems Advancet%ent Committee Meeting April 20,1993 New York City In attendance were: Pat Flanagan (Chairperson, CIA Committee on Pension Plan Financial Reporting), Harry Garber (Society Vice-Presi- dent), Jeffrey Groves (Chairperson, Pension Track Education Objectives Committee, U.S.), Ethan Kra (Vice- Chairperson, Pension Section Coun- cil; Co-chairperson, FAS IO6 Task Force), Rita Lawlor (Chairperson. Re- tirement Systems RacUce Education Committee). Bob McKay (Board Rep- resentative), Curt Morgan (Chairper- son, Retirement Systems Specialty Guides Committee), Mary Riebold (Board Representative). Pat Scahffl (Board Representative). Susan Smith (Chairperson, Retirement Systems Professional Development Commit- tee), and Michael Sze (Chairperson. Retirement Systems Research Com- mittee). Also attending were Judy Anderson (Society Staff Representa- tive) and Barbara Choyke (Society. Staff Representathfe).

1. Report &om the Won 8eetioncoundl

The Pension Section Council will again Include a member survey with ballots this year. Survey questions will Include feedback on SGA ser- vices, for example. which meetings were attended and why. The number of questions should be limited to a manageable size.

2. Meetings and Speaker Recndtment

The Society meetings are within weeks of the Conference of Consult- ing Actuaries and Enrolled Actuaries meetings. Therefore, the Pension Section requests later dates and western sites for the Society Spring Meeting that it cosponsor. The Pen- sion Section has also experienced some difficulty In recruiting speakers.

It was suggested that the meet- ing format be changed from the traditional four or five tracks of 90- minute sessions to two or three par- allel tracks using a full or half-day seminar format. Under the proposed format, fewer topics would be pre- sented but with much more depth, and there would be fewer speakers to

recruit. However, speakers would be required to do more work and plan- ning. A seminar format could also be another way to distinguish Society meetings from the other organiza- tions’ meetings.

This suggestton was also pre- sented at the Pension Section Coun- cfl meeting in April. The Section Council and the Retirement Systems PracUce Advancement Committee concurred that we should try to implement the seminar format at the 1994 Spring Pension Meeting. Ethan Kra will prepare a memo for the Society Task Force on Program Site Selection.

ASB Standards and Specialty Guide topics (for example. mergers and acquisitions) were menUoned as possible topics for the seminar format.

Under a seminar format, publi- cation of a full transcript, like the Record would be extremely dimcult. It may also be less useful. It was suggested that copies of the seminar handouts replace transcripts in the Record and that tape recordings of the sessions be available to those interested in additional detail.

It was suggested that PensIon Sectbn News publish a list acknowl- edging the speakers at the pension sessions at the San Diego meeting. Judy Anderson will discuss this idea with the Editor of the Per&on Section News and forward the list of speakers.

It was also suggested that we keep a record of past speakers and their topic, particularly those that were well received. Even if the same speakers do not have the Ume to vol- unteer again, they can often suggest others and perhaps act as mentors.

3. Dak4baseon&tualiesinthe Rethmcnt Syatcm~~ Practice Arna

We will be using the Society database to profile the retirement systems actuaries and their activities. To ident.@ actuaries In the Retirement Systems FVacUce area, we will include all Pension SecUon members, all EAs and all actuaries who selected the pension specialty as the area of practice.

4.

Practice /r

8ociety tkmias to Retirement t3ystemsActuaries

There was a lengthy discussion on services the Society provides to retirement systems actuaries and on the priorities assigned to the resources for these acUvlUes.

. Job Opporhmitics. ‘lh committee was support&e of the SocIeQ% becomIng more involved in IdentQing altemauve career path and new areas for the pension act-s sldlls. We should work to expand the defi- nition of the pension actuary. We should also encourage those that have gone into nontraditional work to publici.~ their activities.

l cOntinutngEducation.There

was a sentiment to continue to emphasize seminars.

l PuUcationm. A more ~nsoltdated approach to the various Society publi- /? cauorls. including indexes, PASCS and the Reconi was discussed. There was intent in the poeslblUUes that the electronic bulletin board and new technokgywilI provide.

l Retward Them was support for the demographic studtea (mortality, tum- over, retirement) that the Retirement Systems wh Committee is pre- paling. There was also support for continued publication of Ecaurndc stausticsfa~lorl-.

It was suggested that we try to open communications with the Empm Benefits Research Institute (EBRI). ‘l-hey may be interested In joint research and would be In a position to protect the anonymtty of sources for the data collected.

MikeSzepxuvidedalJstof Retirement Systems Research colllmlttee prowts.

There was support for the work on post&irement health and analysis of claim Incidence. One SuggesUon was that the Practice Education Committee publish an article on the Implications of the FAS 106 reseaxrh ’ This should be done together with the Health Systems Practice Educa- tion committee.

aDntlnrredunpage17,cfllumnI

SEPTEMBER 1993 PENSION SECIION NEWS PAGE 17

Minutes of the Retirement Systems Practice Advancement committee Meeting continuedfrompoge 16

The retirement systems practice area issues will be discussed at the June meeting of the Society Execu- tive Committee. Harry Garber will

m distribute his notes, based on this discussion, before the Executive Committee meeting.

The next meeting of the Retire- ment Systems Practice Advancement Committee will be held in July.

Respec(fuUy Submftted, Judy F. Anderson. FSA Ekiucation Actuary

Actuaries Online wntlndfrompage 1

Subscribers can also wniribute to the libraries to share reports, data. etc. with other professionals.

l Online searchable databases for locating actuarial resources, actuarial programs and fellow actuaries iiom around the world.

From the general Society perspec- tive, members will be able to use the service to order books and study materials. not@ the SGA ofilce of Dlrectoq changes, view meeting and seminar programs, register for them online, and see examination pass lists.

Other proposed uses include the posting of employment opportu-

nities. providing online access to the Dtnday and using the BBS as a central distribution point for regulatory notices and updates.

Other actuarial organizations will be invited to participate tithe setvice. Its success depends on its usefulness to actuaries in all busi- nesses. InformaUon and expertise will be available that until now has been limited to meetings or other specialized programs.

The Society staff is on target for a 1993 implementation of the ser- vice. Further InformaUon will be sent to members as it becomes available.

James Weiss is Dhxtor ojIr$omxatfon .Sendoes at the Sodety ofA-s in Schnumburg. Nfnofs.

TSA1991-92 Reports Feature Three Pensim studies About October 1. the Transac- tions of the Society of Actuar- ies, 199 l-92 Reports will be mailed to members. Contained in this volume are three expe- rience studies of particular interest to pension actuaries: l ‘Moitaliiy among Members of

Uninsured Pension systems,” ii-am the Retirement Plans IQqxrienceCommittee

l “Mortality under Individual Immediate AnnuiUes, f&e Income Settlements, and Matured Def& Annuities between 1976 and 1986 Anniversaries,” i+om the Individual Annuity Experience comnlittee

l ‘Motity under Structumd Settlement Annuities.’ also from the Individual Annuity Experience Committee.

The Retirement Plans Experience Committee was chaired by Ed Hustead. and the Individual Annuity Experi- ence Committee was headed by Phil Bieluch.

Artides NeededforNews tour help and participation are Pension Section News- needed and welcomed. All articles Preferred Format will Include a by-line (name, with title and emplayer. If you wish) to

In order to eflIciently handle articles,

give you full credit for your effort. please use the following format

Vews is pleased to publish articles when submhting articles.

In a second language if a tI-anslaUon Mail articles on 5l/4” diskette

Is provided by the author. For those using either ASCII or WordPerfect

If you interested in working on the 5.1 Ales. or send scannable copy,

Vews. several Associate Editors are i.e.. typed copy that is single-spaced with 72-character lhres. Headlines

needed to handle various specialty areas such as meetings, seminars,

are typed upper and lower case.

symposia, wnttnuing education Carriage returns are put in only at

meetings, teleconferences, and cas- the end of paragraphs. The right-

settes (audio and video) for Enrolled hand margin is not justified.

ktUtieS, mW pension Study notes. If this is not clear or you must

sub&t in mother manner, new research and studies by Society COIllIIlitteeS. and SO Oll. If yOU would

please cd Mb- Simmons

like to submit an article or be an 708-706-3562 at the Society of

Associate Editor, please give me a Actuaries for help.

call at 203-521-8400. Please send original hard copy

of article and diskette to: News is published quarterly Rs followa:

Publication Submtssfon Date Deadline

December November 10 March February 10 June May 10 September August 10

As in the past, lull papers will be published in The Pension ~bnun format, but now only on an ad hoc basis.

Barbara Simmons Society of Actuaries 475 N. Martlngale Road Suite 800 Schaumburg. IL 60173-2226

Please send a copy of article (Ilard copy only) to:

Daniel M. Arnold, FSA, K!lA Hooker & Holcombe. Inc. 65 LaSalle Road West Hartford, CT 06107

Thanks for your help.

Dan Arnold, Editor Phone: 203-521-8400 Fax: 203-521-3742

PAGE 18 PENSION SECTION NEWS SEPTEMBER 1993

ContinuingEducationUpdate by Barbara 8. Choyke

The following list identifies pension programs that the Society of Actuaries has scheduled (to date) for Fall 1993. Several other opportunities are being planned, and information regarding these and other programs will be sent to the member- ship in the coming months.

Seminars

September 23. lQQ3

Teleconference: Qualified Retirement Plans-Final Nondiscrimination Rules, Legislative Update and Participant-Directed Plans Cosponsored with the American Bar Association and telecast live across the U.S.

Pension Sessions at the Annual Meeting

October 17-20. 1993 New York City

Monday, October 18

9PD Late Breaking Developments 13ws Computer-Assisted Learning Tuesday. October 19 31PD Another World: FASB 41ws Computer-Assisted Learning

(Repeat of 13WS) 48PD Discrimination Issues-Here Today, Gone Tomorrow

F/U 76WS 58WS Computer-Assisted Learning

(Repeat of 13WS and 41WS) 68PD 76ws EEtXZ%X~ Issues Wednesday, October 20 89PD 95ws 98WS

108PD 109PD 117Ws

127PD 128PD

w

GIC Alternatives and Synthetics Small Plan Topics Computer-Assisted Learning

(Repeat of 13WS. 41WS. and 58WS) Canadian Pension Regulatory Environment Role of the PBGC Computer-Assisted Learning

(Repeat of 13WS, 4 1 WS. 58WS and 98WS) Defined-Contribution Plan Compliance Professional Ethics

220 min.

90 min. 90 min.

90 min. 90 min.

90 min.

90 min.

90 min. 90 min.

90 mm 90 min. 90 min.

90 min. 90 min.

90 min. 90 min.

C

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NC C

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C m

C/NC NC

$NC C

C C

NC C

Just a reminder!

For those actuaries who need to keep track of EA credit, I strongly urge you to prepare a file folder in which you place descriptions of the seminars, sessions, speakers, articles, or any other materials that will serve as documentation for your activity. Be sure materials include dates and locations to help you track your progress. If you have any quesUons about these programs, wntlnuing education in general, or enrolled actuary credit, please call the Continuing Education Department, 708-706-3545. Watch your mail for brochures on programs for 1993-94.

Barbara S. Choyke is Doctor of Contfnuing Education of the Soctety of Actuarfes.